Tuesday, July 29, 2008

As I rationalized here, there are currently some beaten up stocks in the small cap aerospace and defense sector. I argued that the sharp price drops and low price to book ratios (P/B) make some of those stocks appear to be undervalued.

Calculating the historic price to book ratio on some of those small cap stocks can be used to further indicate relative value. In order to compare the current P/B values to the historic averages I constructed table 1:

Table 1: Price to Book Ratios for selected small cap aerospace and defense sector companies for the 2000 - 2008 time period

A few observations are clear from the numbers in table 1. First, the current P/B ratios for all three small cap stocks (TATTF, OSI, ARTX) are considerably below their historic averages. Secondly, the P/B ratios for those same stocks are at or extremely close to their all time low P/B ratios over the 2000 - 2008 time period. We can conclude that these small cap stocks appear to be very cheap compared to their historic P/B levels.

Would I recommend buying these stocks with just this analysis? Definitely not.

In order to be confident of a buy, we should have a deep understanding of these businesses and the industries they operate in to be reasonably certain of their true asset values and earnings power. However, the current analysis does offer up 3 potentially very cheap aerospace stocks that can be further researched to determine their true intrinsic business values. A rigorously calculated intrinsic business valuation compared to current market prices will demonstrate whether those companies are truly undervalued or not.